Investing in new capital is not enough. The bigger challenge is to preserve whatever we have built
Most of us are familiar with the term ´investment´ which, actually, is a process of building up wealth, like constructing a house, buying a business or investing in the stock market. By the nature of what constitutes an investment, its value will fluctuate over time—up or down—depending on factors that affect its market price. However, one thing remains constant: the value of these investments can, at most, decline to zero but never become negative. This is common sense.
Now, what has been said above applies to ´personal investment´. There is another category of investments called ´national investment´. The difference between personal investment and national investment is that the latter excludes financial investment—like the purchase of stocks and debt certificates. National investment comprises of exclusively non-money items—building of physical assets used in production. Some of these assets provide direct help to production—factory buildings, equipment, transport system, and new innovations such as computer and internet. Other types of physical investments—roads, bridges, electric grid, irrigation canals, schools, and hospitals—are indirectly useful for production.
Investment drives growth
Investment—or national investment as defined above—is important because this drives economic growth. Generally, if investment is low, economic growth will be lackluster, and vice-versa. Economic growth is the key to prosperity; lack of it dooms a country to penury.
Economists measure the size of national investment in terms of gross domestic investment—how much of capital assets get built over a year that are available for use in production. Gross investment is paired with Gross Domestic Product (GDP)—as ratio of investment level to GDP—to assess the investment size.
So what level of investment is needed to produce a healthy growth rate—say, 3-4 percent per capita—which, in Nepal’s case, should be nearly 6 percent, or about twice the rate we have historically had?
Experience across countries and over time shows that, controlling for other variables that have important consequences on economic growth, countries must have an investment rate in the twenties—around 25 percent of GDP—to attain 6 percent or above growth. This doesn’t work out exactly year-after-year but, over long periods—ten or twenty years—this relationship does seem to hold for most countries.
Although whatever has been said above is a standard theory, in reality, this may not be precisely or even roughly correct. This particular theme has been aptly explained by William Easterly, in his book Illusive Quest for Growth. There, he points out the case of Zambia. With investment that Zambia made over the 30-year-period until the mid-1990s, its per capita income should have grown to US $20,000, but it actually ended up with just US $600—a level not much different from what it started with!
There are a number of ways we can explain this disconnect between national investment level and economic growth, particularly in the countries that are badly governed and mismanaged. One of the key factors contributing to this disconnect is the incidence of corruption which tends to divert investment funds into other uses.
However, there are other—more powerful—reasons that make investment much less useful in terms of its contribution to economic growth.
It is common knowledge that investments in physical capital are long-lasting but not permanent. All of them have a useful life-span, measured in terms of depreciation, obsolescence, and outright destruction—effects of floods, earthquakes, wars. Depending on the quality of investment assets (buildings, equipments, roads, railway tracks, irrigation canals, electric grids), they will lose productivity as they age, and new investments are needed to replace them.
How large is this negative component of capital? This is an important piece of information because netting this amount out from current investment yields capital growth—assuming that net amount remains positive.
There is no accurate or even roughly accurate estimate of how much investment is lost each year to use, misuse and obsolescence but, in the US, for example, this loss-investment level has been almost one-to-one in recent years, which means that net growth in capital stock is nonexistent. There are many reasons for the slowing down of US economy—in the past ten years, growth has averaged a mere 1.6.percent a year—but the main reason must be the weak pace of capital accumulation.
For Nepal, evidence suggests capital accumulation has been negative for many years, which means a declining capital stock, mainly owing to four important reasons.
First, a significant part of new investment ends up as current spending—contracting, consultancy fees, and technical assistance, for example—and are not used for buying bricks, concrete, mortars, and equipment that make up the physical capital.
Second, low quality assets that get built—roads, bridges, irrigation canals, structures, transport equipment, for example, also contributes to negative capital growth. The incidence of low-quality capital assets is pervasive in the public sector—shallow asphalt-paving of roads, and bridges with shaky anchoring, for example—but this also affects the quality of private sector investment, like when contractors use poor quality cement and untreated timber in house construction.
[Remember the incidence of late KP Bhattarai’s residence collapsing just a year after it had been built!].
Third, poor repair and maintenance work to keep existing capital stock in usable condition and to slowdown its wear and tear. Many of us remember once the trolley-bus service and Sajha transport operating in Kathmandu; a ropeway connecting Amlekhgunj and Thankot; and a rail track from Raxaul to Amlekhgunj. Another significant piece of public investment, Janakpur Railway, is collapsing due to years of neglect and unavailability of funds for repair and maintenance...
To this list, we can add Nepal Airlines Corporation (formerly RNAC) which has depleted its capital stock to the point of a near collapse.
Fourth, the privatization binge that occurred during the early years of democratic rule in the 1990s, when most publicly-owned industrial enterprises were sold to private businesses at give-away prices. Privatization was supposed to create new vigor for industrial growth by helping re-capitalize and bring new technology and management to privatized enterprises. Instead, most of them—some profitable and employing thousands of workers—collapsed within a few years of privatization. Its latest victim is the Himal Cement Factory that has been closed for eleven years and is now turning into scrap.
We need to add the wastage of capital over many decades and then visualize the magnitude of development problem we face. It wouldn’t be unreasonable to assume that most or the entire 25 percent GDP equivalent we spend on investment may barely cover our capital wastage through corruption, low quality investment, lack of repair and maintenance, and sheer abandonment of existing capital stock. Overall, net capital formation, on a national level, will be close to zero or even negative.
It is high time that our policymakers wake up to—what I call—the tragedy of capital formation which perpetuates our subsistence economy. It is not enough to invest large amounts to build new capital. Rather, the bigger challenge is to preserve whatever we have built, in the form of valuable capital assets. Unfortunately, this capital-saving investment needs to come out of our own savings. For whatever reason, foreign aid for repair and maintenance and for replacement of worn-out assets is hard to come by.